Full Definition
A Quality of Earnings (QoE) report is the foundational financial due diligence deliverable in any M&A transaction, typically prepared by an independent accounting firm retained by either the buyer (buy-side QoE) or the seller (sell-side QoE or Vendor Due Diligence). The report examines whether reported EBITDA reflects sustainable, repeatable earnings or is inflated by one-time items, aggressive accounting policies, timing distortions, or structural costs that will not recur. The output is a "Adjusted EBITDA Bridge"—a detailed reconciliation from reported EBITDA to normalized, run-rate EBITDA with each adjustment clearly defined and documented. Key areas of QoE examination include: revenue recognition policies and their compliance with ASC 606 (identifying any pull-forward or aggressive recognition), related-party transactions that may be on non-arm's-length terms, revenue concentration risk and customer retention trends, accrued expense adequacy (identifying any understated liabilities), working capital normalization across seasonal cycles, and identification of non-recurring costs versus recurring structural expenses. A thorough QoE will also examine the company's management reporting infrastructure—whether internal numbers are reconciled to GAAP, whether the close process is reliable, and whether the company has the finance team capable of managing post-transaction reporting requirements. Sell-side QoE reports prepared before launching a sale process allow sellers to identify and proactively address issues that would otherwise surface during buyer diligence, potentially derailing the transaction or creating price reductions at closing. They also create auction efficiency—buyers who receive a credible sell-side QoE can accelerate their diligence timeline, increasing the likelihood of closing. However, sophisticated buy-side advisors always conduct their own independent QoE regardless of whether a sell-side report exists, as the seller-retained firm has inherent incentives to present the most favorable view of earnings quality.
FAQs
Who pays for a Quality of Earnings report and what does it cost?
Sell-side QoE is paid by the seller (or their PE sponsor) and typically costs $150K-$500K depending on company size and complexity. Buy-side QoE is paid by the acquirer and costs $200K-$750K for mid-market transactions, with large enterprise transactions reaching $1M+. The cost is justified by the protection it provides—identifying $5M of unsustainable EBITDA that would translate to $40M+ of overvaluation at 8x multiples.
What is the difference between a sell-side and buy-side QoE?
A sell-side QoE is prepared by the seller's advisors before launching the sale process and is typically shared with prospective buyers. It presents the most favorable defensible view of earnings quality. A buy-side QoE is prepared independently by the acquirer's advisors and is inherently skeptical—designed to identify risks and downside adjustments the seller's report may have minimized. Both use the same methodology but serve opposite advocacy positions.
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